The Reality of Government Spending and Money Supply 16 comments
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According to conventional wisdom, the Federal government spends taxpayers' money. In reality it spends its own base money and recaptures it with taxes and the sale of bonds. In the long run it must spend at least as much as it recaptures. Otherwise the economy would be drained of the base money it needs to operate. Base money underlies the money supply of the private sector, which consists mainly of bank deposits, i.e. bank money. In order to influence the amount of bank money issued, the government must control the cost of acquiring base money which banks need to cover their depositors' transactions.
The Importance of Government Spending
The Treasury can be viewed as a money pump that continuously recycles base money with the private sector. The outflow due to government spending is matched on average by the inflow from taxes and bond sales. Government spending engages the private sector in work which would otherwise not be performed under private initiative. An example is the building of the interstate highway system.
The outflow also includes various subsidies and transfer payments that may not directly engage work, but are important in redistributing purchasing power. That in turn results in income to firms and their employees. Note that government spending of any kind redistributes income. It is beneficial to the extent that it contributes to a robust economy, with a decent standard of living for all citizens.
Compensating for Treasury Spending
The Treasury pays the government’s bills out of its account at the Fed. Those payments inject new deposits and reserves of base money into the banking system. Since that would increase the money supply and interfere with the Fed’s ability to implement monetary policy, it compensates in the following ways:
- When tax revenues do not fully recapture government spending, the Treasury recaptures the excess with the net sale of its securities. Conversely if the Treasury receives more tax revenues than needed to recapture its spending, it net redeems its securities. Government spending therefore has no direct effect on the aggregate money supply, on average.
- As it spends, the Treasury replenishes its Fed account with equal transfers from its commercial bank accounts, where it deposits its receipts from taxes and bond sales. This removes the reserves of base money created by its spending. Aggregate reserves of the banking system therefore remain unchanged, on average.
The Balanced Reciprocal Flow of Funds
In effect, the Treasury simply recycles base money previously created by the Fed. Its outflows and inflows move bank deposits and reserves around the banking system without changing the total on average. The Treasury has no use for balances in its own bank accounts in excess of what it needs to cover its near-term payments. It normally holds about one week's worth of government spending, which currently averages about $60 billion.
The long term increase in the public's money supply is due to (1) net borrowing from banks and (2) the increasing demand for currency. As the money supply increases, the Fed must inject reserves into the banking system to balance supply against demand at its target Fed Funds rate, its primary monetary policy tool. It does so by purchasing Treasury securities held by the public.
Why the Treasury Can Always Sell its Securities
As long as the Federal government enforces tax collection, its base money will be in demand. Since base money earns no interest, when the private sector has more than it desires to hold in the aggregate its only interest-earning alternative is Treasury securities. The Treasury can pay whatever interest rate the market demands, so there will always be willing buyers of its securities.
Disclosure: Author is invested in various mutual funds, mainly at Vanguard
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"In the long run it [government] must spend at least as much as it recaptures. Otherwise the economy would be drained of the base money it needs to operate."
of course this is a good argument why the government should spend and tax less. in fact this is an argument why governments need to minimize their consumption in the monetary system as it distorts the non-governmental portion of the money supply where the real economic work is performed.
but what happens when the government turns on the taps and spends massively more than it takes in? how is this difference (which i will call debt) metabolized in the monetary system? Doesn't government debt itself create instability in the money supply, and massive debt creates massive instability? My point is after the money is spent and it performs its "work", isn't debt a black hole which sucks money in which could be used for productive "monetary work".
William, i got hung up on the words "at least" in the quoted paragraph as this seems to be the current battle cry of treasury and the fed to try to short circuit the economic collapse we are experiencing. i am afraid it it will not have any effect on the economic free fall, and will restrain economic recovery.
The most erroneous and misleading statement in the article was: "The Treasury can be viewed as a money pump that continuously recycles base money with the private sector." The public purse is a sewer that pollutes and destroys wealth. Imagine a society that taxed its citizens of every cent saved, every cent of profit, to feed government. Impossible? Nope. We're headed in that direction at a gallop.
When a private citizen pays tax, it is money out of his pocket.
When a government-funded recipient "pays" tax, it's a meaningless discount offset by public pensions and guaranteed employment.
If you read about Hajek, en.wikipedia.org/wiki/... then you will find out why not everything you have in the US is so great. Fed and money circulation was even present in communist russia, so nothing really estonishing.
The quesiton is rather whom you tax and how much and what the government spends it for.
Well, you ton't tax the rich (they get cuts from Bush ????) , they got greedier and more and more ...
You spend your money on war (where nobody really seems to complain about governmental intervention) and oil for big cars that you don't want to buy any more - ho ho
Now that Obama wants to tax the rich and spend money on schools you are all crying socialism, as if your portion of capitalism was something that special in this world.
NO, IT IS NOT - you have just been fucked by the rich people that always take money from the poorer (not china or some terrorist, no your own people)
Unless the party which buys the Treasury securities is the FED. Then the money supply skyrockets. See St. Louis FED graph of adjusted monetary base:
research.stlouisfed.or...
"Government spending engages the private sector in work which would otherwise not be performed under private initiative."
Because there is no profit in the undertaking of such projects, which essentially means there is insufficient demand from consumers to make the expense worthwhile. Naturally the gub'mint isn't interested in meeting actual demands of the marketplace, but in directing public monies to political cronies regardless of the usefulness of the undertaking. Think "bridge to nowhere".
"The outflow also includes various subsidies and transfer payments that may not directly engage work, but are important in redistributing purchasing power."
Which as we all realize is the primary purpose of gub'mint. Steal from the productive and give to the unproductive in exchange for votes, or as H L Mencken stated:
"Every election is sort of an advance auction sale of stolen goods."
Could the author elaborate as to WHY redistributing purchasing power is "important"? Important to whom? Certainly not to those who are taxed to support the 'redistribution'.
I'm sure everyone out there is as thankful as I am that the gub'mint is taking my hard earned money and spending it on things we don't really need and/or using it to buy votes from people who don't produce anything at all.
Gosh, just imagine how horrible things would be if we all got to keep everything we earned instead of having the gub'mint steal it from us for unwanted or wasteful spending.
"Violent unrest may be sparked around the world by a prolonged global slump unless governments act with greater urgency to jump-start stalled economies, the head of the International Monetary Fund said on Monday." (London Times)
Couldn't get past this one early line...lost credibility and didn't even finish reading. CLUE train for the author: the government HAS NO base money of its own -- every penny it has, is given it by WE THE PEOPLE, to do OUR BIDDING. It has ceased to do so. But the fact remains that every penny the government has, comes from us. Even when they create more currency and coin...WE are paying for them and own them...via inflation.
ANSWER: The Fed creates all base money in the process of monetizing the Federal debt via open market operations. Neither we the people nor the Treasury create base money. We the people sell our Treasury securities to the Fed to acquire base money. The Treasury acquires base money through taxes and if necessary the sale of its securities to we the people.
On Dec 16 01:59 PM Socialism cannot compete! wrote:
> "In reality it spends its own base money and recaptures it with taxes
> and the sale of bonds."
>
> Couldn't get past this one early line...lost credibility and didn't
> even finish reading. CLUE train for the author: the government
> HAS NO base money of its own -- every penny it has, is given it by
> WE THE PEOPLE, to do OUR BIDDING. It has ceased to do so. But the
> fact remains that every penny the government has, comes from us.
> Even when they create more currency and coin...WE are paying for
> them and own them...via inflation.
Note that deficit spending has no direct effect on the money supply. In the aggregate the private sector pays for the Treasury securities it buys out of the deficit spending itself.
On Dec 16 05:39 AM The hand wrote:
> william, welcome to seeking alpha. avowed keynesians are always
> welcome as they bring fresh meat to the table.
>
> "In the long run it [government] must spend at least as much as it
> recaptures. Otherwise the economy would be drained of the base money
> it needs to operate."
>
> of course this is a good argument why the government should spend
> and tax less. in fact this is an argument why governments need to
> minimize their consumption in the monetary system as it distorts
> the non-governmental portion of the money supply where the real economic
> work is performed.
>
> but what happens when the government turns on the taps and spends
> massively more than it takes in? how is this difference (which i
> will call debt) metabolized in the monetary system? Doesn't government
> debt itself create instability in the money supply, and massive debt
> creates massive instability? My point is after the money is spent
> and it performs its "work", isn't debt a black hole which sucks money
> in which could be used for productive "monetary work".
>
> William, i got hung up on the words "at least" in the quoted paragraph
> as this seems to be the current battle cry of treasury and the fed
> to try to short circuit the economic collapse we are experiencing.
> i am afraid it it will not have any effect on the economic free fall,
> and will restrain economic recovery.
>
On Dec 16 11:25 AM Smarty_Pants wrote:
> "When tax revenues do not fully recapture government spending, the
> Treasury recaptures the excess with the net sale of its securities.
> Conversely if the Treasury receives more tax revenues than needed
> to recapture its spending, it net redeems its securities. Government
> spending therefore has no direct effect on the aggregate money supply,
> on average."
>
> Unless the party which buys the Treasury securities is the FED.
> Then the money supply skyrockets. See St. Louis FED graph of adjusted
> monetary base:
It meant banks were forced into percentage quotas of bad loans (call it what you want, it is a quota). Later, it was further pushed by both Clinton and Bush II.
Then when very public warnings and restatements came from within Freddie and Fannie, there was a call for oversight. It was Democrats in congress that stopped oversight of Fannie and Freddie in 2003. YES DEMOCRATS!! And that is why America is bankrupt today. It will be an unbudgeted 3 Trillion when all is said and done. See link below for proof.
www.taxfoundation.org/...
The rich.... ??? What are you talking about? The bottom 50% of Americans pay just 3.07% of all taxes! And the top 10% of Americans pay over 70% of all taxes. Just what is it you want??? Again, see link for proof.
www.taxfoundation.org/...
Can you provide any links to data???
On Dec 16 09:55 AM Vienna wrote:
> Interesting, the article states about things that would not be done
> by private initiative. Why should the author be a avowed keynesian,
> because great USA has a fed that pumps money, every banana republic
> has this.
>
> If you read about Hajek, en.wikipedia.org/wiki/...
> then you will find out why not everything you have in the US is so
> great. Fed and money circulation was even present in communist russia,
> so nothing really estonishing.
>
> The quesiton is rather whom you tax and how much and what the government
> spends it for.
>
> Well, you ton't tax the rich (they get cuts from Bush ????) , they
> got greedier and more and more ...
> You spend your money on war (where nobody really seems to complain
> about governmental intervention) and oil for big cars that you don't
> want to buy any more - ho ho
>
> Now that Obama wants to tax the rich and spend money on schools you
> are all crying socialism, as if your portion of capitalism was something
> that special in this world.
>
> NO, IT IS NOT - you have just been fucked by the rich people that
> always take money from the poorer (not china or some terrorist, no
> your own people)
So if 45% of US treasuries are held abroad. How do we pay that back with a consumption and service economy, no personal savings and limted manufacturing to export?
Thank you for responding. It is a frustrated world right now.
On Dec 16 09:59 PM William Hummel wrote:
> The Treasury normally sells its securities only to the private sector,
> not the Fed. The only reason it sells its securities is to cover
> its own deficit spending. The outflow due to its spending is matched
> by the inflow from the sale of its securities. Thus there is no net
> change in the amount of base money.
Hi,
I think I have seen to many statistics. In Europe we don't freak out too much about the statistics, as we have learned in the last few month they tend to be faked to make everybody happy.
I read the articles about eg.
warren Buffet his taxation and that of his secratary (I wonder if he would lie about this public, or not recall the statement if this is made public on a broad base)
about tax cuts for rich ...
And I did not read them just but many times, on many sites on many different occasions. I read and see a lot about increasing profits of international corporations, I audited one today EBITDA 60%, and they can't get enough.
US surely had a good time, but the rest of the world is free now, and as we learn in economics it is all about limited resources. Well these are now used by China and India on a larger scale.
The time of unlimited growth can not be kept up with in the long run, world population is simply to large. We in Europe know that social stability has its price, so does China from a long history.
On Dec 16 10:11 PM Hmm?! wrote:
> It is called the community redevelopment act. Started by Jimmy Carter....
> the man who brought America.... 17% interest rates... 11% unemployment
> and the unstable middle east of today (IRAN hostage affair).
>
> It meant banks were forced into percentage quotas of bad loans (call
> it what you want, it is a quota). Later, it was further pushed by
> both Clinton and Bush II.
>
> Then when very public warnings and restatements came from within
> Freddie and Fannie, there was a call for oversight. It was Democrats
> in congress that stopped oversight of Fannie and Freddie in 2003.
> YES DEMOCRATS!! And that is why America is bankrupt today. It will
> be an unbudgeted 3 Trillion when all is said and done. See link below
> for proof.
If the bottom 50% where only paying 3%, why should they be shouting for tax cuts, well obviously they are already have such a low income.
if so it is obvious that the top percentage has accumulated so (too) much money.
This will eventually lead to big stress in the population. They are now being told that is is some foreign power that is taking their money, but look at corporate profits and the wealth of a few individuals.
Believe me, we had this, so now we have a tax of 50% for the rich with a minimum wage regulation etc. (funny that especially the people with huge wealth tend too complain the most)
And further funny enough, the 50% are even too low, as for some people to gain huge fortunes on the back of a large majority.
If you speak with people who study natural biological live cycles, systems like this have to collapse, since the system work through the principle of live and let live. They way US corporations have been acting, it is solely based on making profit, no matter what, as we currently can see in many instances. This natural behavior has to be regulated.
The recovery after the War in Europe was based on trust and companionship, this has disappeared.